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a. Fair Market Value Analysis
In the first part of his analysis, Hakala valued petitioner
based on two “rules of thumb”: (1) three times “owners’
discretionary cash flow” and (2) five times earnings before
interest (the net of interest income and interest expense) and
taxes (only Federal income taxes), or EBIT. Owners’
discretionary cashflow is the sum of EBIT, Jack’s compensation,
and Mary’s compensation. Hakala states that, because only the
owners’ discretionary cashflow measure is calculated before
deduction of officers’ compensation, the difference in value
between the two measures provides an implied amount of excess
compensation. For 1995 and 1996, Hakala calculated implied
excess compensation of $356,942 and $412,625, respectively. By
subtracting the amounts of implied excess compensation from the
amounts that petitioner paid to Jack, Hakala determined an
implied amount of reasonable compensation of $405,244 for 1995
and $450,934 for 1996.
In his expert witness reports, Hakala included tables
showing how his fair market value analysis would apply if
petitioner had paid to Jack only the amounts that Hakala
concluded would be reasonable compensation. In his original
report, in which he concluded that maximum reasonable
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